A large chunk of the DXY gains is actually driven by Euro exchange rate weakness in the wake of the continuing Italian crisis.

This has caused EUR/GBP to drop back down to prices last seen in June around the 0.87 level, and EUR/USD is at 1.15 again.

Euro longs will hope for some quiet from Italian politicians as every time they speak the selling seems to intensify with the League's Matteo Salvini latest rant accusing both EU officials and speculators of seeking to bring down Italy.

The situation was calmed somewhat by the Finance Minister Giovanni Tria who said that the government is worried about the 'unacceptable' yield spread, and the market reacted by narrowing it slightly.

The spread between the Italian and German 10Y government bond yield is close to 300bp, the highest in five years.

Trump Weighs in on US Yields

Yields in the US eased ever so slightly on Tuesday, which was enough for equities to at least stabilize in the US. The S&P500 held Monday’s low and, while no reversal is in place yet, sentiment is improving.

Some of the stall in the yield rally could be attributed to President Trump, who again expressed dissatisfaction with the pace of Fed. Yet Trump does seem reluctant to make any more than comments at this stage and admitted he has not spoken to Fed Chairman Powell directly on this matter. We can perhaps assume that the market will therefore ignore his comments in the medium term as it has ignored all previous comments.

Emerging Markets Resilient

One feature of the markets over the past week or so is the apparent strength in emerging markets. The bulk of the selling has been in US and Europe, and emerging market equities have not crashed to new lows. Chinese equities have held their September lows and many currencies, notably the Turkish Lira, have been resilient in the wake of rising US yields and a rallying US dollar.

Yet while a crash seems less likely now, emerging markets are still a cause for concern among many investors. ING bank recently hosted Emerging Markets Traders Association (EMTA) meetings in Singapore and Hong Kong and asked attendees their views on a number of the key drivers of 2018. The responses were firmly tipped towards a bearish outcome.

“The audiences in both settings were still negative, with 38% more votes by the audience in Singapore for a further sell-off over the coming 12- months than for a rally and a 40% margin in Hong Kong favouring more selling.

The biggest negative shock that could make for an even bleaker outlook would be an acceleration in US inflation, coupled with a slowdown in the US and/or Chinese growth. That was seen as combining all the most negative components that would result in a much more aggressive EM sell-off, dashing hopes for a rally.”

And echoing the views of many analysts, the expectation is for the trade war to get worse before it gets any better.

“With worsening US-China trade relations at the back of many investors' minds, we also asked the audience whether they saw a resolution to the trade war within a 12-month window. The vast majority, by more than 34%, thought that it would get worse, rather than better. “

Recent relative strength in emerging markets could very well just be a break in the selling.

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James Elliot

James Elliott is an entrepreneur and an independent trader. After retiring in his early 30s, James started a...